TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
0 H% R5 ]2 a' [8 z: D" t8 |from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
! U0 W2 V: |/ ]$ L3 {prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
9 e% l0 H! g% o& _$ F" l+ }that exceeded its fundamental-justified level by approximately
$ @+ g, T1 g. h12%, an excess that was exaggerated in the past
) J# Z, [  E' \3 M( e% w6 F4 I- Zthree years.
" B  W9 e2 j$ B5 q/ p3 B3 m: dBy “overpricing” we mean that prices detached from
  w! ?7 ?7 n. h+ \& atheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
- T4 ?5 J$ Y0 U& J% ?both a cyclical downturn and a return of house prices
8 ~" W6 s' `/ h- Y/ rto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
$ t% Y7 [4 d" T5 A/ ^% J; u/ twhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
1 |) c4 C1 ?6 `# H3 p& N' Jwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
/ N, v* u& l% q0 ]“overbuilding” was mainly of the first type, where
3 Q$ T/ t; Z  hhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
8 t8 `7 H5 h! J, ~4 l4 L, DWhile most markets won’t face U.S.-style overhangs,
; U: O2 Z# h4 Gthe construction of too many new homes over the boom
; h8 I' Q3 P; a  Omeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
9 q6 L5 G- f2 c* mremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
4 q$ C) T, `8 Q  M+ G! t# L# G) O- @2 _to persist over 2009 to 2011. We anticipate that nationwide
8 {. _/ L( a$ u4 xresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
/ R2 H" \: S3 d5 B% Nin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
  H2 J3 O6 |7 L# G3 Vfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
" X, h$ n: l/ w+ pregard housing prices and household formation as the drivers
7 t! J* u1 A: n* v2 Z8 [/ m6 kof residential construction.
% {3 O/ P  n( H8 Y. X" ATo examine the degree of overbuilding, we employ a
6 I! ~( K# ~5 S, Z0 J* F“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
1 H2 P# W( R# Z5 I+ E$ c2 poptimally. We find that actual homebuilding exceeded this
$ K  b- c6 J0 x; V: W8 ~5 a. j9 S1 afundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
  D2 C: G# Q7 C/ pwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
, ]1 N; t# D' }( s. L  T# fvery time that the resale market has swung into strong
- E  r7 y$ L0 I; ~! bbuyers’ territory. Homebuilding in the Atlantic provinces
/ T( F1 f5 l( khas been relatively balanced but, while not plagued by structural
  b8 X5 |7 ~- O1 v; wweakness, will be singed by the downturn nonetheless.
/ k0 F* P) u( `) {4 _! j- RQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
/ q7 H1 K& D# _Montréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
8 f+ e9 g$ E! ?0 Krates. While Ontario homebuilding will reel from a
6 y9 T4 |+ C5 m$ r- Q+ zcyclical downturn, the degree of structural weakness appears
" u) x) f6 C# D, _  [/ Olimited – with the important exception of the Toronto
1 [1 o' p6 c$ ?0 O( f4 S9 Xcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
$ b% ]' ?9 k0 m* ~% X8 Sreach completion during 2009. If absorption rates fall, as
; U7 h) F$ A; x6 t# @/ M4 Dcyclical factors would indicate, condo inventories could
) `2 R2 N$ v+ y) {spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
# B! w# n! [9 N4 D6 Q: Vwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
1 u6 [- y5 T( C# z  x$ VMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
+ B- \/ A( L' {0 x: \0 H. a416-982-8063
. D1 C' I$ o4 Z$ FPascal Gauthier, Economist
1 }% w# p0 C% S. Z( j+ Q2 o. _9 x6 H416-944-5730
' ]2 K$ W: p3 u# f" f
% u4 {0 @( m3 u  j* chttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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